Starting 2015 with a smart investment strategy

Tuesday 13th January 2015

Written by Mike Abbott, Sable Wealth

2014 was a tumultuous year for markets. Not only did the FTSE All-share drop sharply in autumn, the end of the year brought research revealing that active managers had their worst year since at least 1989. Astonishingly, almost 90 percent of them underperformed.

One lesson to take from this is that when it comes to markets the only certainty is uncertainty. This leaves us with a challenging question: how can we create a safe and sensible investment strategy for 2015? We say you shouldn’t try to second-guess the market. Instead, this month you should focus on ensuring some good financial housekeeping. You’ll then be able to start 2015 with peace of mind and the best possible chance of a strong return.

Ignore the prophets

You may have seen the recently published research from the State Street Center for Applied Research entitled “The Folklore of Finance”. It explores ‘how beliefs and behaviours sabotage success in the investment management industry’. This research found that fund managers’ pursuit of success resulted in certain shared (false) beliefs governing their behaviour, which in turn amounted to the industry spending 60% of its capital expenditure chasing an alpha performance that industry professionals themselves admit is more likely to result from luck than skill.

What can we learn from this? Primarily that it pays to be wary of ‘hot’ funds and ‘godlike’ fund managers promising the world. If it sounds like it’s too good to be true, it probably is. There are a number of expert financial planners who can help build well-balanced portfolios supported by global strategies and local specialists; look to them for advice and be willing to stay your course.

Assess the risk and diversify

Without wishing to state the obvious, investing always carries an element of risk. But, risk and return are always intertwined. It’s important to only take risks you can both afford and understand. The level of risk will of course vary for each individual, but try to remember that investing too little can be just as risky as investing too much, as you may fail to meet your long-term financial needs. The trick is to take the right amount of risk so that you can weather the storms and see the long-term plan through to fruition.

This risk also extends to the type of investments you make. It is true that studies have shown that, in the long-term, equities tend to outperform other asset classes. But, in reality, you should diversify your portfolio in order to protect yourself from asset specific risks. Make sure your portfolio has a mixture of equities, fixed income, and property, and ensure these are represented across all sectors. And think globally: if you have assets across multiple jurisdictions then your portfolio will be far more diverse and less vulnerable.

Risk vs Uncertainty

It’s also important to remember the difference between risk and uncertainty. The former is the range of known potential outcomes (good and bad). The latter is the unknown outcomes (good and bad) that you cannot plan for. The prevalence of uncertainty increases the need to understand your own personal ‘capacity for loss’. Focusing only on risk appetite creates the potential for uncertainty to lead to unbearable losses.

Looking long-term

Returning to ‘The Folklore of Finance’ report, it highlights what we believe to be the primary issue around investment - the meeting of long term goals. This process is better known as financial planning, but investment management is only one aspect of this picture and meeting long term goals requires the management of many moving parts, rather than a heavy reliance on the pursuit of alpha.

It’s common to attribute our successes to skill and our failures to bad luck, but historically asset class returns display random distributions and we often overestimate our timing skills. Consistently successful market timing is a myth. It’s important to remember that trends are often temporary. The key is to keep calm and have confidence in your long term strategy; don’t jump ship the moment the market fluctuates.